Advertising cash-on-cash

[Marc Freislinger]

As I understand it, cash-on-cash return is the difference between your annual return and your total investment. I often see properties advertised as 15% - 25% cash on cash return. How can you determine this number without knowing what sort of down payment the investor will use? Or, since you're always looking for a cash buyer, wouldn't the actual return be extremely low?

Help me understand.

I'm looking at a deal with the following details:

Duplex: 3/1.5 and 3/1.5
Asking: $16,900
Rehab: $15,000
Rents: $1,200

Using the 50% rule, I get a cash flow of $193/unit. Which, to me, seems to be worth looking into, but if I paid cash for the property and the rehab, my total investment is $31,900.

So, $1,200 / $31,900 = 4% cash on cash return. Doesn't sound so appealing. But, let's say I assume the investor can finance 80% (including rehab), leaving a down payment of $6,380. That makes the cash-on-cash return 19%. Sounds more appealing.

So, do I just make up whatever numbers I want? Or what is the standard way of doing this? I apologize if I'm missing something dumb.

[J Scott]

Originally posted by Marc Freislinger:

...cash-on-cash return is the difference between your annual return and your total investment.

Just a nit-picky thing, but it's the *ratio* of the return to the investment, not the difference... (though I think you know that, just want to make sure others do as well).

In your second scenario below, where you determine your COC based on a financed purchased, it appears you're forgetting to subtract out the debt service you'll have to pay on the financed piece.

For example, in your numbers below, your COC if you purchase for full cash will be:

($600 * 12) / $31,900 = 22.5%

Now, if you put down 20% and finance the other 80%, you're correct that your total investment drops to $6380, but remember that your monthly cash flow will drop as well, due to the mortgage payments you'll be making.

In this case, assuming 7% interest over 30 years, your monthly debt service will be about $170. That drops your annual cash flow by (12 * $170), or $2040. That leaves $5160 in annual cash flow.

So, your COC for this scenario is:

$5160 / $6380 = 80%

In this case, your COC increases dramatically with the leverage you obtain.

In most situations the COC won't increase that dramatically (yours is pretty unique in that you're getting $1200 in rent on a $30K property), but given reasonable interest rates, you'll generally see an increase in COC when you leverage.

Also keep in mind that I didn't factor in any loan costs or closing costs in the scenario above...even if you paid only $2000 out-of-pocket in loan/closing costs to get that 80% financing, your COC would drop to around 60%.

As for how COC is advertised, it needs to be advertised in conjunction with a specific scenario. For example:

"Cash-on-cash return of 16.8% with a 20% downpayment, and financing of 80% at 7% interest over 30 years."

Only with at least that much info is COC meaningful.

Does that answer your question?